The IRS Commissioner’s Warning of Audits to Come

I n a letter to members of the United States Senate, Internal Revenue Service Commissioner Charles Rettig did his part to carry water for the Biden administration’s push for $80 billion in new funding to his agency. Rettig argued that the IRS does not have “the resources that it needs to ensure the tax laws are enforced fairly and that Americans receive the level and quality of service they deserve.” On the heels of this plea, the Senate passed the Inflation Reduction Act, which the president signed on August 16, 2022.

The IRS will get its $80 billion. Nearly $46 billion is going to enforcement. With that, the agency intends to hire nearly 87,000 new employees over ten years, the same window of time over which the $80 billion will be spread. (For context, the agency currently has about 82,000 employees. And so there is no way that, with normal attrition and retirement over ten years, the IRS will end up with a doubling of its workforce in that time.) The commissioner’s letter provides a glimpse into the administration’s thinking when it comes to tax policy generally, and IRS enforcement in particular. It isn’t encouraging.

For example, the commissioner accuses “large corporate and high-net-worth taxpayers” of engaging “teams of sophisticated representatives who pursue unsettled or sometimes questionable interpretations of tax law.” The commissioner insinuates that corporations and the rich simply cheat on their taxes. He says, “This creates a direct revenue loss from evaders and lessens the potential to deter others from pursing a similar path of noncompliance.” Hence the commissioner’s argument, that a “strong, visible, robust enforcement presence,” is necessary to ensure compliance.

This argument ignores the fact that both the American Bar Association (ABA) and the American Institute of Certified Public Accountants (AICPA) each adopted — decades ago — ethical standards of practice pointed directly at legal and accounting professionals in the tax-planning and return-preparation businesses. The ABA standard, expressed in Formal Opinion 85-352, requires that a position taken on a tax return at the advice of an attorney must be “warranted in existing law or can be supported by a good faith argument for an extension, modification or reversal of existing law and there is some realistic possibility of success if the matter is litigated.” To be sure, tax pros have an affirmative duty to represent the best interests of their clients. But they also have a duty to follow the law in the process. Failure to do so places that professional’s license and livelihood at risk.

The commissioner’s statements suggest that the IRS is the final arbiter on all matters regarding tax law. But that’s not the case. The U.S. courts ultimately decide whether the law has been properly applied, and that is often at odds with the IRS’s opinion. As I document here, the IRS is wrong between 60 and 90 percent of the time (depending on the issue) when it comes to its audit results.

The problem is that most people do not challenge IRS audits because of the perception that the IRS must be correct, or that one just can’t fight back. The facts prove otherwise. In 2021, the IRS and U.S. taxpayers settled 19,963 cases docketed in the U.S. Tax Court. A total of $4.29 billion in taxes and penalties was at stake in those cases, and they were settled for $1.30 billion. This means that taxpayers owed just 30 cents on the dollar compared with the IRS’s allegations. Even that number is deceptive because in tax litigation, citizens reach a point where they must make a business decision the IRS never has to make. The agency might litigate over $50, but citizens have to balance the time, cost, hassle, and energy of fighting against the cost of a settlement. Citizens routinely settle tax cases for an amount they can live with, but which does not necessarily represent the true amount owed. The IRS knows this, so the agency pushes the envelope.

This is made clear in the disclaimer statement presented in its tax-guidance publications. The IRS produces and distributes through its website hundreds of official publications intended to explain the law in simple and non-technical terms. Publication 17, for example, Your Federal Income Tax (2021), is a 140-page guide to tax-law compliance for individuals. The small-print disclaimer reads:

The explanations and examples in this publication reflect the interpretation by the Internal Revenue Service (IRS) of: Tax laws enacted by Congress, Treasury regulations, and Court decisions.

Now, what happens when certain court decisions are at odds with the IRS’s “interpretation”? According to the disclaimer:

This publication covers some subjects on which a court may have made a decision more favorable to taxpayers than the interpretation by the IRS. Until these differing interpretations are resolved by higher court decisions or in some other way, this publication will continue to present the interpretations by the IRS.

It is clear that the agency does not apply “unsettled or questionable interpretations” in a manner most favorable to taxpayers. It sticks with its own interpretation. Yet when taxpayers or their counsel apply “unsettled or questionable interpretations” in their own favor, even when done in good faith, they are said to be tax “evaders.”

Nothing could be further from the truth. There is a remarkable distinction between tax avoidance and tax evasion — the willful and deliberate attempt to defeat the payment of taxes that one lawfully owes — that has been recognized by the courts for generations. Tax avoidance — claiming an itemized deduction for mortgage interest, for example, deducting charitable contributions, or otherwise taking advantage of existing tax-code provisions — is a perfectly legal way to reduce one’s taxes. As the Second Circuit Court of Appeals said in 1934,

Any one may so arrange his affairs that his taxes shall be as low as possible; he is not bound to choose that pattern which will best pay the Treasury; there is not even a patriotic duty to increase one’s taxes.

A person who in good faith takes a position that has some reasonable basis in the law is not “evading” tax. The commissioner and the Biden administration know that perfectly well, but it can be politically useful to elide the difference. And that’s easier to do when, as is the case under our current tax law, almost everybody can be made out to be a criminal.

The solution to this problem is not more money to the IRS so it can conduct more audits, the results of which are likely to be mostly erroneous. The solution is to abolish the Byzantine tax code and the army of IRS officers charged with enforcing it. We have to stop tinkering around the edges with tax “reform.” We must bulldoze the income-tax system and start over with a broad-based consumption tax.